Commercial real estate represents nearly one-quarter of the Salt Lake City bank's total loan portfolio, and, although it drove a small increase in originations, has become more risky throughout the year. Still, Zions doesn't expect to see major losses even as real estate contributed to a rise in problem loans, said CEO Harris Simmons on the fourth-quarter earnings call.

"Credit quality measures for the total CRE portfolio remained relatively strong, though criticized and classified levels increased in the quarter," said CFO Paul Burdiss on the Monday earnings call. "Overall, we continue to expect the CRE portfolio to perform well with limited losses based on the current economic outlook." 

The $87 billion-asset bank said it has taken a harder look at the underwriting of its commercial real estate portfolio, which led to a 2% quarterly increase in loans in the fourth quarter. While net charge-offs are rising across banks, like PNC, Ally and Regions, Zions saw a quarterly drop. However, loans that show signs of risk, like nonperforming assets and classified loans, rose.

Still, Simmons said that Zions is comfortable with its credit performance, and was "particularly pleased" with the credit quality of its loan portfolio. The company also brought in $583 million in net interest income, a 19% drop from the prior year, primarily due to a rise in expenses. 

Compass Point Research and Trading analysts wrote that they were surprised by Zions' confidence in minimal credit losses despite the rise in classified loans. A Wedbush analyst note, which rated Zions as neutral, wrote that the bank's credit quality was "mixed," and that a recession could negatively impact the company's fundamentals. 

At Zions, more than 20% of its office loans are showing signs of risk. Two previously reported suburban office loans totaling $46 million account for more than half of the increase in nonperforming assets at Zions. The bank's office portfolio, which makes up 15% of its total commercial real estate loans, or 3% of its total loans, is facing "continued challenges'' that the bank is working through, said Chief Credit Officer Derek Steward on the call.

Office loans across the country are causing problems for banks, as high interest rates and work from home trends put pressure on the sector, according to an academic paper published by the National Bureau of Economic Research. Nearly half of banks' office loans have balances greater than the property's worth, the research showed. Guidance from the Mortgage Bankers Association expects commercial and multifamily mortgage borrowing and lending to pick up in 2024, but still remain muted. 

"2023 is likely to go into the record books as the slowest year for commercial real estate borrowing and lending in roughly a decade," said Jamie Woodwell, the MBA's commercial real estate research lead, in a prepared statement. "As the markets reset – on interest rates, property values, some property fundamentals and other factors – those volumes should pick up marginally."

Steward said future losses are difficult to predict, but that he doesn't expect major losses from Zions' $3.7-billion multifamily portfolio, which makes up more than one-fourth of its commercial real estate book. Although the percentage of risky multifamily loans at the bank more than doubled in the fourth quarter, Steward said the stress in the business came from delayed construction, higher interest rates and longer-than-expected timelines for filling leases.

"The fact that we're seeing increased levels of criticized [loans] isn't a great concern," Simmons said. "In recent years, the equity going into [multifamily] deals is probably double what it was a decade ago, and so there is a lot more cushion and ability for these deals to experience some slowdown."

Zions expects loan balances to remain "stable" in 2024, due to higher interest rates and uncertain economic outlook resulting in weak demand. 

The company's stock fell 1.25% to $42.77 on Tuesday.